2018 AGM and reporting season: narrative reporting issues

Non-financial reporting

In our 2017 AGM season briefing, we wrote in detail about the EU Directive on Disclosure of Non-financial and Diversity Information (2014/95/EU) (the Directive) and its implementation by (i) the Companies, Partnerships and Groups (Accounts and Non-Financial Reporting) Regulations 2016 (the regulations) and (ii) changes to the Disclosure Guidance and Transparency Rules (DTRs) (see next article for DTRs aspects). We have also written in our 2017 Quoted Company Newsletters about FRC publications issued to assist companies with reporting in these areas, namely a Factsheet in July and Frequently Asked Questions (FAQS) in December.

The regulations amend the Companies Act 2006 by adding new sections 414CA and B requiring disclosures by way of the non-financial information statement (NFIS), effective for certain listed groups (therefore not AIM companies, unless they are banks or insurance companies) with more than 500 employees) for financial years beginning on or after 1 January 2017. Although the NFIS has a significant overlap with the existing strategic report disclosure requirements for quoted companies, there are key differences and relevant companies should review their existing disclosures and add in any new disclosures.

We set out below a brief summary of key points (for more detail generally see our September and December 2017 newsletters).

Non-financial reporting key points - general and FRC FAQs

• What companies are covered by the Regulations? The FAQs contain a useful flowchart to assist companies with the interplay between pre-existing section 414C (7) (the existing "enhanced strategic report" requirements for quoted companies) and new section 414CB on the non-financial information statement. It confirms, for example, that for non-parent companies with 500 or fewer employees, there is no change in their reporting, but that for all traded companies (eg listed companies) and also for banking and insurance companies (whether traded or not) with over 500 employees, the regulations apply. 
• What are the new requirements? The FAQs mention the need to include "to the extent necessary for an understanding of the company's development, performance and position and the impact of its activity" information on: environmental matters (including impact); employees: social matters; respect for human rights; and anti-corruption and bribery matters. 
  This must include, in relation to the above areas, descriptions of: policies and their outcomes; due diligence processes; and principal risks in connection with the above matters. Additionally, where proportionate, there should be a description of its business relationships, products and services which are likely to cause adverse impacts and how the company manages the principal risks. 
• For existing quoted companies, what are the new disclosures? The most significant new disclosures are described as those on: the impact of the company’s activities (ie the effect it has externally); anti-bribery and anti-corruption matters; principal risks;  business relationships, products and services which are likely to cause adverse impacts; and due diligence.
• Materiality. Disclosures are only required if material, which the FRC see as a proxy for "to the extent necessary for an understanding of the company's development, performance, position and the impact of its activity". 

Diversity reporting

Diversity reporting under the DTRs. As mentioned, the Directive also deals with reporting on diversity. These elements of the Directive have been implemented by way of new DTRs 7.2.8A and B, which will require for relevant issuers, broadly large listed companies, similar information on diversity matters to those already covered by provision B.2.4 of the UK Corporate Governance Code, but again with a few differences that mean companies in scope should check that their diversity reporting in their 2017 accounts complies, bearing in mind in particular that the DTRs are mandatory and not comply or explain.

DTRs 7.2.8A and B - key requirements to be described

• The diversity policy applied as regards for instance age, gender or educational and professional backgrounds. (This is wider than B.2.4 of the UK Corporate Governance Code in that it goes beyond gender.) 
• If there is no policy, an explanation as to why not.
• The policy's objectives. (Unlike B.2.4, this assumes there are objectives.)
• How the policy has been implemented. (This is also wider than B.2.4.)
• Results in the reporting period.

For more detail on the DTRs, see our September 2017 newsletter. 

Reporting on diversity on boards - Hampton/Alexander supplementary report

In our 2017 AGM season briefing, we wrote about the issue by the Hampton-Alexander Review of its FTSE Women Leaders report with its recommendations for diversity targets across boards and across executive committees and their direct reports. In November 2017, the Review published a supplementary report on improving gender balance in FTSE leadership. For more on the progress in meeting the targets, see our December 2017 Quoted Company Newsletter. 

Most companies now submit to the Review their data on achievement of the targets and many also note diversity achievements in their annual reports. Given the now mandatory diversity reporting required by the DTRs, as mentioned above, this is likely to increase.

A change that the Review steering group has decided to make is to extend the target of 33 per cent women across executive committees and their direct reports to FTSE 250 companies (as well as FTSE 100 companies). Such companies will want to consider whether to adopt and report on the newly applicable target.

Reporting on ethnic diversity the Parker Review Committee final report

We also noted in our 2017 AGM briefing that the Parker Review Committee had published a consultation version of its report on the ethnic diversity of UK boards. In October 2017, the final report was published. 

Ethnic diversity reporting - key points

• Increasing the ethnic diversity of boards to have at least one director of colour by 2021 for FTSE 100 companies and by 2024 for FTSE 250 companies.
• Developing and promoting candidates of colour in the pipeline of board candidates.
• Enhancing transparency and disclosure. For example, the description of the board's policy on diversity in its annual report should include the company's efforts to increase ethnic diversity in its business and on its board and companies that do not meet the board composition targets by the suggested dates should explain why not.

FRC publications

Summary of key developments for 2017/2018 annual reports

In October 2017, the FRC wrote its annual summary of key developments for annual reports in its end-of-year letter to audit committee chairs and finance directors. It covers aspects of annual reporting where companies should improve and highlights changes to reporting requirements. 

At the same time, it published its annual review of corporate reporting covering much the same ground as the end of year letter, but in more detail. On narrative reporting, some key points from both documents, are set out opposite.

FRC key points for annual reports

• Strategic reports. These remain subject to much FRC challenge. Companies are encouraged to improve where there is a lack of disclosure or a lack of balance and also to explain the relationships and linkages between different disclosures, for example, between key performance indicators and remuneration policies. 
• Drivers of value and long-term success.  Companies should be transparent about their key sources of value, how they are managed and how value is likely to be generated. They should also consider broader drivers of value that contribute to the long-term success including those not recognised in the financial statements such as a highly-trained workforce and stakeholder engagement.
• Performance reporting. The FRC commonly identifies reports where not all key aspects of performance have been considered. Companies should explain changes to key performance indicators and make clear, company-specific disclosures.
• Brexit disclosures. Whilst a consistent theme is of continuing uncertainties and it being too early to measure longer-term effects, companies are starting to identify in more detail the likely risks. Companies should disclose their latest analysis of how their assessment of the potential impact on their business has developed over the year.
• Risk reporting and viability statements. Investors are calling for differentiation in time periods for viability statements used by different companies and sectors bearing in mind the broad range of factors that should be taken into account and not just the company's medium-term business plan. See the FRC Lab report (noted overleaf) for more detail.
• Dividend disclosures. 48 per cent of FTSE 100 companies and 30 per cent of FTSE 250 companies are now reporting information either on the level of distributable reserves or that distributable reserves are sufficient or significant. This area continues to attract investor focus and the FRC urges companies to adopt the recommendations in the October 2017 FRC Lab study on dividends (mentioned overleaf), in particular reporting on capacity to pay dividends, including how distributions might flow to the top company and the extent of any restrictions.

FRC Lab reports

In 2017, the FRC Lab issues project reports on the following areas:

• Risk and viability reporting. Amongst other things, this report highlights the importance of principal risk reporting which: is specific to the company; is clearly linked to its business model; shows any change in risk year on year; and gives some indication of the potential impact of risks occurring. On viability statement reporting, the report highlights for example that investors are looking for companies to: explain their long-term prospects more clearly; to consider their prospects over the longer term relative to their specific business; and to give information on the stress and scenario testing that has been done on the company's resilience to risk. 
• Disclosure of dividends – policy and practice. This report examines how companies have responded to the Lab's 2016 report on disclosure of dividends including how dividend disclosure have improved, examples of developing practice and opportunities to take things further.
• Audit committee reporting. This report by the FRC's audit and assurance Lab (AA Lab) looks at external reporting by audit committees. It considers how investors' confidence in audit is enhanced by, and audit quality promoted through, reporting by audit committees in the annual report and it also updates views of good practice on audit committee reporting. The report covers most of the aspects that audit committees deal with including: appointment; tendering; independence and effectiveness of the external auditor; reporting on significant issues; and internal control and risk management. 
• Digital future of corporate reporting. This report relates to financial reporting, rather than narrative reporting, and looks at how corporate reporting can be improved using technology, specifically the use of "eXtensible Business Reporting Language" (XBRL) tagging of financial statements which will make them more accessible and machine-comparable for use by investors as they make their investment decisions.

Investment Association publications

IA principles of executive remuneration

In November 2017, the IA published its annual update of its principles of executive remuneration (the principles) ahead of the 2018 AGM season. Changes from the previous version are not substantial and include: the insertion of new guidance on relocation benefits; updating the section on annual bonuses, including on disclosing bonus targets and deferring bonus payments; and reorganisation of the section on long-term incentive schemes, to give a clearer picture of members' attitudes to specific scheme types.

The accompanying letter to remuneration committee chairs of FTSE 350 companies highlights certain items of focus for the IA's members in 2018. 

IA key items of focus

• Levels of remuneration. This covers, for example, restraint on variable pay increases, justification of levels of pay taking account of the wider social context, pay ratio disclosures and pensions disparity.
• Remuneration structures. This includes noting the need for flexible structures appropriate to the business and also the concern that in some cases new remuneration structures are only proposed when the current ones are not paying out to executives.
• Shareholder consultation. This notes that the consultation process can be improved in some cases and that where resolutions have been withdrawn before AGMs, companies should conduct a full analysis of shareholder feedback and consult further before re-submitting their remuneration policies.
• Pay for performance. This includes that greater transparency will be expected on financial targets as well as on personal and strategic performance targets to show the link between pay and performance which investors will closely scrutinise.

Investment Association in guidance on long-term reporting

In May 2017, the IA published new guidance on long-term reporting. It is intended to complement the Companies Act 2006 strategic reporting regime and the FRC's Guidance on the Strategic Report. The guidance is for companies with a premium listing, but companies with a standard listing or AIM or High Growth Segment companies are encouraged to adopt it. It sets out detailed recommendations in the key areas noted below.

IA guidance on long-term reporting

• Business model and long-term reporting
• Productivity
• Capital management
• Material environmental and social risks
• Human capital and culture

The Institutional Voting Information Service, the corporate governance research arm of the IA, will start monitoring implementation of the guidance for annual reports for year-ends on or after 30 September 2017, and will outline to IA members those companies that continue to adopt short-term reporting models.

Other UK and US guidelines

The Pensions and Lifetime Savings Association (PLSA)

In Hidden Talent: what do companies' annual reports tell us about their workforce, the PLSA and Lancaster University examine corporate reporting on employment models and working practices across the FTSE 100. The report looks at the following areas as key for investors as regards the workforce: composition; stability; skills and capabilities; and engagement levels. 

It concludes that there are substantial variations in the quality of reporting on the workforce and that the onus is on companies to provide better information and on investors to ask for it. It encourages both to engage with recent initiatives for better reporting such as the PLSA stewardship toolkit for pension funds – understanding the worth of the workforce issued in 2016 and the IA long-term reporting guidance (mentioned above).

In January 2018, the PLSA issued its updated Corporate Governance Policy and Voting Guidelines which aim to promote the long-term success of the companies in which the PLSA's members invest and ensure that boards and management of such companies are held accountable to shareholders, such as pension funds.

PLSA governance policy and voting guidelines 2018 - key changes

• New section on sustainability. Amongst other things, the new section suggests shareholders should not support re-election of the chair where, after attempts by shareholders to engage, companies fail to provide a detailed risk assessment on, and response regarding, the effect of climate change on their business and fail to incorporate appropriate expertise on the board. The new section also suggests that shareholders should consider voting against the annual report or the re-election of the chair where they believe that key stakeholder relationships are being neglected.
• Audit and audit committees. Changes include: the need for members of the audit committee to be independent not only of executives but also of the auditor; considering a vote against the audit committee chair and auditor where an auditor has been in place for more than 20 years; mention of the need for professional scepticism by auditors; and that companies should spend no more than 50 per cent of the audit fee on non-audit services (or a material monetary sum - £500,000) absent an explanation of exceptional circumstances.
• Employment model and working practices. A strengthening of the guidelines here so that failure to provide a fair and balanced explanation of the composition, stability, skills and capabilities and engagement levels of the workforce would render a vote against the annual report to be appropriate.

Institutional Shareholder Services (ISS)

ISS, the influential US provider of corporate governance services has issued its policy updates and voting guidelines for the 2018 season. As mentioned in the AGM section earlier, the key change is its new guidance on virtual-only and hybrid AGMs. 

Another area of change worth pointing out is "overboarding" (the holding of too many other positions). Here, ISS has simplified its wording on the positions it considers acceptable for a director to hold (but still recommending that more than five mandates at listed companies will be considered overboarded). It has also changed its wording as regards a chairman who is "overboarded" and when it would recommend targeting the chair position itself. 

Other changes on audit and remuneration committees, threshold levels for long-term incentive plans and share issuances without pre-emption are described as clarificatory.

Glass Lewis

Glass Lewis, another US provider of governance services, has also issued its 2018 proxy guidelines. Areas of update that it highlights in its Summary of Changes for the 2018 UK Policy Guidelines include the following. 

• Board diversity and skills.
• Renumeration.
• Company responses to shareholder dissent of more than 20 per cent.

Glass Lewis has not added anything on virtual-only AGMs to its UK guidelines. In its updated US guidelines it states that whilst in 2018 it will not make recommendations solely on the basis of a company holding a virtual-only AGMs, it has concerns about the ability of shareholders to meaningfully communicate with management. Therefore, in its 2019 US guidelines it will generally recommend voting against "members of the governance committee" of a board where the company holds a virtual-only AGM and does not provide robust disclosure in the Proxy Statement assuring shareholders that they will be given the same rights and opportunities to participate as they would at an in-person meeting. Glass Lewis therefore seems more open to virtual-only AGMs in the US, but it remains to be seen what, if anything, it might decide to say in its UK guidelines in the future.

Miscellaneous reporting requirements

This section briefly looks at miscellaneous reporting requirements which, whilst not for inclusion in the annual report, merit a mention.

Reporting on business payment practices and performance - now in force

We have covered this new requirement for large companies to report twice a year on payment practices and performance in various client briefings since 2016.

The Reporting on Payment Practices and Performance Regulations 2017 (SI 2017/395) and the LLP equivalent regulations (SI 2017/425) each came into force on 6 April 2017 and apply for each relevant company in a group (broadly all companies unless medium sized or smaller under the Companies Act 2006) with financial years beginning on or after that date. The regulations are supported by Guidance to reporting on payment practices and performance issued by the Department of Business, Energy and Industrial Strategy.

The first entities have now reported under the new regime. Their reports are accessible on the Government website. 

December year-end entities will have a first reporting period of 1 January 2018 to 30 June 2018 and will need to file their first report on or before 30 July 2018. For more on the regime, see our March and December 2017 Quoted Company Newsletters. 

Gender pay reporting

The regulations on mandatory gender pay gap reporting came into effect on 6 April 2017 for each company in a group which employs 250 or more employees. Non-statutory guidance on the regulations is available to assist employers. The deadline for publishing the first set of data is 4 April 2018 and a number of employers have already begun to upload their gender pay gap data onto the Government website as well as Companies' own websites. The information must be confirmed as accurate by a director. 

Please see our briefing on the top five issues for employers as well as an updated version of our more detailed briefing on the regulations.